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Persistent Appreciations and Overshooting: A Normative Analysis

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  • Ricardo J. Caballero
  • Guido Lorenzoni

Abstract

Most economies experience episodes of persistent real exchange rate appreciations, when the question arises whether there is a need for intervention to protect the export sector. In this paper we present a model of irreversible destruction where exchange rate intervention may be justified if the export sector is financially constrained. However the criterion for intervention is not whether there are bankruptcies or not, but whether these can cause a large exchange rate overshooting once the factors behind the appreciation subside. The optimal policy includes ex-ante and ex-post interventions. Ex-ante (i.e., during the appreciation phase) interventions have limited effects if the financial resources in the export sector are relatively abundant. In this case the bulk of the intervention takes place ex-post, and is concentrated in the first period of the depreciation phase. In contrast, if the financial constraint in the export sector is tight, the policy is shifted toward ex-ante intervention and it is optimal to lean against the appreciation. On the methodological front, we develop a framework to study optimal dynamic interventions in economies with financially constrained agents.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13077.

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Date of creation: May 2007
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Publication status: published as Ricardo J Caballero & Guido Lorenzoni, 2014. "Persistent Appreciations and Overshooting: A Normative Analysis," IMF Economic Review, Palgrave Macmillan, vol. 62(1), pages 1-47, April.
Handle: RePEc:nbr:nberwo:13077

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Cited by:
  1. Smith, Constance E., 2011. "External balance adjustment: An intra-national and international comparison," Journal of International Money and Finance, Elsevier, Elsevier, vol. 30(6), pages 1195-1213, October.
  2. repec:dgr:uvatin:2011068 is not listed on IDEAS
  3. Nicolás Magud & Sebastián Sosa, 2013. "When And Why Worry About Real Exchange Rate Appreciation? The Missing Link Between Dutch Disease And Growth," Journal of International Commerce, Economics and Policy (JICEP), World Scientific Publishing Co. Pte. Ltd., vol. 4(02), pages 1350009-1-1.
  4. Jeffrey Frankel & Ben Smit & Federico Sturzenegger, 2008. "South Africa: Macroeconomic challenges after a decade of success," The Economics of Transition, The European Bank for Reconstruction and Development, The European Bank for Reconstruction and Development, vol. 16(4), pages 639-677, October.
  5. Jeanne, Olivier, 2013. "Macroprudential policies in a global perspective," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Nov, pages 1-38.
  6. Daniel Lederman & William F. Maloney, 2012. "Does What You Export Matter? In Search of Empirical Guidance for Industrial Policies," World Bank Publications, The World Bank, number 9371, August.
  7. Jeffrey Frankel, 2007. "On the Rand: Determinants of the South African Exchange Rate," NBER Working Papers 13050, National Bureau of Economic Research, Inc.
  8. Adriana Soares Sales & João Barata Ribeiro Blanco Barroso, 2012. "Coping with a Complex Global Environment: a Brazilian perspective on emerging market issues," Working Papers Series, Central Bank of Brazil, Research Department 292, Central Bank of Brazil, Research Department.
  9. Cherif, Reda, 2013. "The Dutch disease and the technological gap," Journal of Development Economics, Elsevier, Elsevier, vol. 101(C), pages 248-255.
  10. Rod Tyers & Lucy Rees, 2008. "Service Oligopolies and Australia's Economy-Wide Performance," ANU Working Papers in Economics and Econometrics, Australian National University, College of Business and Economics, School of Economics 2008-490, Australian National University, College of Business and Economics, School of Economics.
  11. Gian-Maria Milesi-Ferretti & Olivier J. Blanchard, 2011. "(Why) Should Current Account Balances Be Reduced?," IMF Staff Discussion Notes 11/03, International Monetary Fund.
  12. Raddatz, Claudio, 2011. "Over the hedge : exchange rate volatility, commodity price correlations, and the structure of trade," Policy Research Working Paper Series 5590, The World Bank.
  13. repec:dgr:uvatin:2010002 is not listed on IDEAS

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